February 29, 2024

Understanding FX arbitrage strategies

FX arbitrage is the simultaneous purchase and sale of a currency pair to profit from a discrepancy in the price. This type of trade exploits the fact that different currency pairs are traded at different prices on different exchanges. So, by buying low on one exchange and selling high on another, it is possible to profit.

While this may sound simple in theory, FX arbitrage is a complex and risky strategy that is unsuitable for all investors. To be successful, traders need to have a deep understanding of the market, access to multiple exchanges, and the ability to execute trades quickly.

How to use FX arbitrage

Identify a discrepancy in the price of a currency pair

The first step is to identify a discrepancy in the price of a currency pair. You can monitor prices on different exchanges or use an arbitrage calculator.

Place orders to buy and sell the currency pair

Once you have found a discrepancy, you will need to place two orders – one to buy the currency pair on the exchange where it is trading at a lower price, and one to sell it on the exchange where it is trading at a higher price.

Wait for the trade to execute

Once your orders have been placed, you will need to wait for them to be executed. It can take some time, so it is essential to be patient.

Close your positions

Once your trade has been executed, you will need to close your positions. You can place an order to sell the currency pair on the exchange where you bought it and buy it on the exchange where you sold it.

What are the risks of FX arbitrage?

The market may move against you

If the market moves against you while your orders are being executed, you may make a loss.

You may not be able to close your positions

If there is a problem with one of the exchanges, you may not be able to close your positions. It could lead to a loss if the market moves against you.

The spread may widen

The spread is the difference between a currency pair’s bid and ask price. If the spread widens, it will eat into your profits.

Benefits of FX arbitrage

You can make a profit in a bearish market

If the market is falling, you can still profit by selling the currency pair on the exchange where it is trading at a lower price and repurchasing it on the exchange where it is trading at a higher price.

You can take advantage of different interest rates

If there is a difference in interest rates between two currencies, you can earn interest by keeping the currency with the higher interest rate.

You can hedge your risk

By simultaneously buying and selling a currency pair, you can hedge your risk and protect yourself from losses if the market moves against you.

You can trade with leverage

Many exchanges offer leverage, which means you can trade with more money than you have in your account. It can increase your profits (or losses) if the market moves in your favour (or against you).

You can trade 24 hours a day

The FX market is a 24-hour market; therefore, you can trade anytime.

What are the challenges of FX arbitrage?

You need to understand the market

To be successful at FX arbitrage, you need to understand how the market works. It includes knowing what factors influence currency prices and how to read price charts.

You need access to multiple exchanges

To take advantage of different prices on different exchanges, you need access to those exchanges. It can be challenging if you don’t live in the same country as the exchange.

It would be best to be patient

It can take some time for your orders to be executed, so you need to be patient. It can be challenging if you are used to trading other financial instruments, such as stocks or futures.

You must have enough capital

To make a profit from FX arbitrage, you need to have enough capital to cover the trade costs. It includes the spread, commissions, and any other fees.

Trade forex with Saxo on a live or demo account today.